As you prepare to do your taxes, you're probably gathering documents from a variety of sources. Then, once you've filed, you may issue a sigh of relief and shove all your paperwork in a corner somewhere. But you might want to hang on to some of it - because it can come in handy.
What records should you keep?
If you're like most people, you've got a lot of records, statements, receipts, etc. Do you have to hold on to every single slip of paper?
Maybe not, but please check with your tax professional for specifics. Some documents are more important than others. As a general rule, you'll want to keep records of your annual income and your deductible expenses. These are the items that the Internal Revenue Service (IRS) will ask for if you are chosen for an audit.
Consequently, you'll want to keep these tax records and receipts:
- Earned income (W-2 forms)
- Investment income (Form 1099s and other brokerage statements)
- Medical expenses
- Taxes paid
- Charitable contributions
- Child care expenses (some are deductible)
- Business expenses
- Professional/union dues
- Education expenses (some are deductible)
- Automobile/travel costs (if they are deductible for your work)
You'll also want to hang on to your old tax returns. You'll find these returns to be quite useful when you file your taxes in the future. For example, when you're preparing your return, and you look over previous years' returns, you may be reminded of important deductions you had forgotten.
How long should you keep records?
Unless you own a warehouse, you probably don't want to accumulate tax records and documents indefinitely. So, how long should you keep them?
Generally speaking, it's a good idea to retain your paperwork until the chance of a tax audit passes - usually, three years after filing. However, if the IRS thinks you might have underreported your income by 25 percent, it has six years to check up on you. Consequently, you may want to keep your tax documents for at least that long.
Nonetheless, there are exceptions to the six-year rule - and the biggest one may have to do with your home. Years ago, if you sold your home, your profits might have been taxable. But the tax rules have changed: You can now net a tax-free capital gain of $500,000 (for married couples) or $250,000 (for single filers) when you sell your home. To determine if the sale profits fall within the tax-free limits, you must verify the "tax basis" (the value of your home when you bought it). Therefore, you need to keep all records, such as settlement papers and receipts for improvements and additions, related to the worth of your home.
Where should you keep your records?
Keeping your records won't do you any good if you can't find them. So, set up a record-keeping system that works for you. You may want to devote a filing cabinet specifically for tax records. Designate individual folders for old tax returns, income, deductions, etc.
Of course, you can also store many records electronically. But if you do, make sure that you've backed them up in some way.
Once you've established a record-keeping process, you'll find it fairly easy to maintain. If you don't have one yet, get started soon - the quicker you organize your tax records, the better.
